Fantasy Tax Reform

by Anne C. Canfield, Denise A. Bode, and Sarah C. Helton

 

Football season has begun, Congress has returned to Washington, and a major push to get tax reform enacted by year-end is underway.  The conventional view in “The Swamp” is that the Republicans will not be successful, and that a small tax package of tax extenders and other assorted revenue items will be included in a year-end Omnibus Appropriations bill.

We have a different view.

After innumerable meetings, reviewing all of the tax reform proposals that have been laid on the table for consideration for the past decade or more, and decades long experience in “reading the tax tea leaves”, we believe there is a better than even chance that the Republicans will be successful in getting tax reform enacted by year-end.  After failing to “repeal and replace” ObamaCare, Republican policymakers know that they must deliver on comprehensive tax reform.  They are also motivated by the belief that comprehensive tax reform needs to be enacted this year to spur more robust economic growth before the 2018 elections.

Republicans can be expected to “move heaven and earth” to get the bill done, including changing some of the arcane rules under which the Senate operates, if needed.  Even if they are not successful in finishing their work before year-end, policymakers have openly discussed completing the package in 2018, but making all or part of the tax package retroactive to 2018 with some of the provisions potentially being made retroactive to 2017.

For the past several months:

  • Key officials in the Trump Administration have been meeting regularly with the key Republican Congressional tax-writing committee staffs to pull together a comprehensive tax reform package
  • The “Big Six” (White House National Economic Council Director Gary Cohn, Treasury Secretary  Steven Mnuchin, House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, Ways & Means Committee Chairman Kevin Brady, and Senate Finance Committee Chairman Orrin Hatch) have been holding weekly calls every Tuesday to review the options the staff developed
  • Beginning in late July, the tax staffs for the Republican Members of the Senate Finance Committee have been meeting regularly to review the options and get agreement from each of their bosses on the items that will be included in the tax package

The bottom line is that the key tax staff has a bill fully written with options “on the shelf” in case adjustments need to be made as the bill moves through the “sausage-making” (i.e., legislative) process.

President Trump has engaged in a full-scale charm program to woo at least three Senate Democrats who are up for reelection in “red” states.  While Congressional Republicans would welcome their support, they are not counting on their votes.  Even with their support, the Republicans would still not have the necessary 60 votes to get a bill through the Senate, unless they change the Senate rules to allow a simple majority to approve a bill.  Absent a rule change, Republicans can be expected to use the Reconciliation process, which requires only a simple majority to pass the bill in the Senate.  The Reconciliation process requires that the Congress agree on a Budget Resolution for FY 2018, which has not yet been done, unless the Senate Budget Committee Chairman overrules the recent Senate Parliamentarian’s recent decision and allow the FY 2017 Budget Resolution’s Reconciliation instruction to be used instead.

So, the following is the “optimistic” timeline that includes projections made by House Ways & Means Committee Chairman Kevin Brady this week:

  • September 14:  Senate Finance Committee hearing on individual tax reform
  • September 19:  Senate Finance Committee hearing on business tax reform
  • September 25:  The outline of the comprehensive tax reform plan that has been agreed to by the “Big 6” will be released
  • Mid-October:  The House and Senate will agree to a FY 2018 Budget Resolution, which will include Reconciliation instructions
  • Mid-October:  House Ways & Means Committee Chairman Kevin Brady will release a “Chairman’s Mark” — a first draft of the detailed tax reform plan
  • Mid-Late October:  The Ways and Means Committee will markup the tax reform bill
  • November: The Senate Finance Committee will markup the tax reform bill
  • November:  Chairman Brady will work with the Budget Committee to bring it to the House floor and passed.
  • Late November – December:  The Senate will consider the comprehensive tax reform bill
  • December 22:  Conference report passed and sent to the President

While negotiations are still ongoing and adjustments are still being made to the tax package, the following is a list of provisions that may be included in the tax package.  Of course, in this fluid environment, the contours and the details of the package can and will change as it moves through the legislative process.

“GUESSTIMATED TAX PACKAGE”

Individual Tax Reform

Rates
  • 7 tax brackets reduced to 4 brackets:
    • Top rate: Applied to very high income individuals
    • 28%
    • 25%
    • 15%
Standard Deduction
  • Doubled:
    • Individuals: $6,300 to $12,600
    • Married couples filing jointly: $12,600 to $25,200
Credits and Deductions
  • Child tax credit increased
  • Earned income tax credit retained
  • Mortgage interest deduction $1 million cap reduced to $500,000; deduction for foreign-owned properties will be repealed
  • Charitable contribution deduction retained and also allowed for non-itemizers
  • State and local tax deduction repealed
Alternative Minimum Tax (AMT)
  • Repealed
Capital Gains and Dividend Income
  • 20% rate
Estate and Gift Tax
  • Will not be repealed due to revenue constraints, but the current $5.49 million exemption will be increased and/or the rate reduced


Corporate Tax Reform

Rate 22% for both C corporations and pass-through entities, but not personal service corporations (PSCs).  PSCs taxed at the individual rate.  A “reasonable compensation” rule would be implemented to differentiate between wage and investment income.
Capital gains 40% deduction of adjusted net capital gain
Corporate Integration:  Dividends paid deduction

40% dividends paid deduction

(Note: As an example, if a corporation had $100 in earnings and paid all of its earnings in dividends to its shareholders, it would then get taxed on $60.  If the corporate tax rate is 22%, the effective rate would then be 13.2 percent.  If it were 25%, it would then be 15% — the corporate tax rate President Trump has advocated.)

Territorial tax system

A territorial tax system, but a 10% minimum tax on global income

(Note: If the budget window is moved from 10 years to 25 years, the 10% global minimum tax might be eliminated.)

Repatriation

Mandatory tax on previously untaxed foreign earnings at 8.75% or 10%.  Discussions are ongoing as to whether a bi-furcated rate should be imposed that would differentiate between cash (8.75% or 10% rate) and other assets (3.5% rate), less proportional foreign tax credit – payable over 8 years.

Interest expense deduction
  • Options:
    • Interest expense deduction limited to a percentage (possibly 66%) of the entity’s interest expense, but an exemption for small businesses up to a specified limit might be given; a separate rule for financial services companies is likely.
    • Interest expense deduction limited to a percentage (possibly 33%) of the company’s EBIDTA.
  • Existing debt grandfathered.

(Note:  These provisions might be phased-in over a period of years as the capital cost recovery provisions are phased-in.)

Capital cost recovery

Based off of the INVEST Act of 2017 (S. 1144) sponsored by Senator John Thune (R-SD):

  • Expensing for investments in business equipment and property (Section 179) up to $2 million, but phase-out the benefit for investments over $3 million; expand Section 179 to a broader range of property and equipment, including roofs, HVAC units, and property used in rental real estate
  • Make temporary “bonus” depreciation into either permanent 50% (possibly 70%) expensing
  • Reduce depreciation for farm machinery and equipment from 7 years to 5 years
  • Increase deduction for passenger vehicles, including light trucks and vans, used for business purposes; full 50% expensing up to $25,000
  • Allow new business owners to expense more of their start-up and organizational expenses
  • Enable small- and medium-sized businesses to use cash accounting method
  • Simplify inventory accounting for small businesses
  • Allow more small construction companies to use the simplified completed-contract method of accounting


Click 
here for a full topline summary of the INVEST Act, here for a section-by-section summary of the bill, and here for legislative text. 

(Note: Some of these provisions might be phased-in over a longer period of time due to revenue constraints as the limitation on the interest expense deduction is phased-in.)

Like-kind exchanges House tax-writers are very focused on “exchange accommodators”.  One option is to return to “like property” for “like property” requirement.
R&D tax credit Retained, but streamlined
NOLs NOLs limited to 90% of taxable income; repeals special carryback rule
Deductions and credits
  • Numerous deductions and credits will be repealed or phased-out.  Those include:
    • Section 199 manufacturing expense deduction is likely to be repealed.
    • Energy tax credits and deductions: current deductions for oil and gas and renewables will be equalized. Changes will be phased-in as industries are transitioned to a level playing field

 

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                  FROM THE CHART ROOM

                  Biggest Power Restoration in History Goes On in Florida

                  irma-power-outages-still-remain(1)

                  Florida may have been spared the most horrible loss of life and destruction of property so many had predicted, but it’s hard to overstate the scale of devastation Irma’s fury brought to the power grid and those who depend on it. At the storm’s height, over 15 million homes and businesses didn’t have service according to the New York Times.

                  The bog challenge becomes turning the power back on in a place whose explosive growth was built on air-conditioning.  The CEO of Florida’s biggest utility, FP&L, said it was the largest restoration in the company’s history.  Eastern Florida should have power back by Sept. 17, while more heavily damaged regions along the west coast will have to wait until Sept. 22. There’s a lot of human misery behind the numbers, with hospitals, nursing homes, schools and more out of commission. One nursing home in Hollywood, Florida has even reported 6 deaths due to the heats

                  The invention of air-conditioning in many ways created modern Florida. At the end of World War II, it fueled a population boom. By the 1960s, the efficient cooling of offices and homes had transformed most everything. The machine that could tackle heat and humidity shifted Florida’s economy from rural to urban. The state’s tourism industry exploded.

                  FP&L has amassed a force of about 20,000 workers at about 30 camps throughout the state for the Irma effort. It has stockpiled thousands of utility poles, transformers and miles of power lines. With gear loaded onto more than 8,000 bucket trucks, crews have been spreading throughout the state to assess damage and make repairs. Crews will first focus on essential services such as hospitals, police, fire stations and shelters. Then will come banks and gasoline stations. Last on the list are lines to individual streets and homes.  Read more at Bloomberg


                   

                   

                  Michael Best Strategies’ Energy Team

                  About Michael Best Strategies

                  Michael Best Strategies focuses on achieving clients’ objectives through unparalleled strategy development and deployment for implementation, pragmatic guidance on public policy development, and government relations. The Strategies team specializes in a full range of services, including government relations, public policy consulting, grassroots advocacy, public affairs, conference planning, and strategic political relationships. For more information, visit michaelbeststrategies.com.